In the United States and Europe faulty credit ratings and flawed rating processes are widely perceived as being among the key contributors to the global financial crisis. That has brought them under intense scrutiny and led to proposals for radical reforms. The ongoing debate, while centred in major developed markets, will also influence policy choices in emerging economies: whether to focus on strengthening the reliability of ratings or on creating alternative mechanisms and institutions that can perform more effectively the role that in developed markets has traditionally been conferred on credit rating agencies.
- Managing conflicts of interest through governance reforms in rating agencies
- Improving the quality of rating methodologies, particularly for structured finance
- Increasing transparency and disclosure obligations
- Introducing direct government oversight to replace self-regulation
Other regulatory measures are also being discussed, ranging from refining existing disclosure requirements to conferring a formal gatekeeper responsibility on rating agencies that would include a due diligence obligation and possibly some legal liability for their rating reports. But some commentators argue that such reforms are insufficient and merely treat the symptoms of the problems and not the root causes. These commentators tend to focus instead on three areas in which there has been much discussion but few reforms:
- Promoting competition in the credit rating industry
- Rethinking the issuer-pays business model and
- Reducing the regulatory franchise of rating agencies.
However, it must be noted that “The rating system goes hand in hand with the development of large liquid, deep and international markets. It is a precondition and a tool for ensuring the smooth functioning of these markets.”
- Report of the High-Level Group on Financial Supervision in the EU
- Turner Review: A Regulatory Response to the Global Banking Crisis
[The article is written by Mr. Varun Joshi. He is the Managing Partner of AV Realty Corp. and is a keen follower of Indian equity market.]